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My latest Digest publication available at http://www.thevaluealliance.com/PDF/CGADigest062810.pdf weaves a number of themes from current news into a picture.

Some of those themes and their meaning may be more apparent than others.

One term I coined in the discussion was “invisible features”. The use of the term ”invisible features” was used to convey the idea that consumers and capital providers are looking beyond what they used to. They are looking beyond what immediately impacts them to “how” something is made. They are looking beyond what immediately impacts them to “how” a company generates its returns. For example, is the environment being polluted? Are human rights being violated? Are stakeholders being harmed?

They are looking at  a whole set of criteria unrelated to the narrow performance criteria that individuals used to use in the past when deciding to purchase an item or buy a stock.

The narrow decision making of the past focused on the performance of the item in relation solely to the individual – does the product perform for me; does the stock perform for me. “Invisible features” mattered less — and when they mattered it usually related to notions of consumer protection in the narrow sense — of the performance features of the item for me. (For example, does the manufactured food contain a harmful ingredient or the toy a feature that may harm the child.)

As a world, we still have a foot in both places — the narrow decision making and the broader one — but the broader one exemplified by the broader “invisible features” contingent is growing larger and more vocal yearly, monthly.

I used the term “invisible features” rather than refer to governance or human rights or the environment or other related descriptions of how products are produced, services are conducted, or companies are run — because using those words creates certain connotations. And more than that, using those words tends to make people think of the ideas as separated concepts, distinct concepts — different from the process of making and selling a product or building a company and selling a stock.

Separate, however, is not the way  those who care about these matters view them — they see them as integral albeit “invisible features” — invisible features to the products and services they fund through purchases and invisible features to the companies they fund through purchases or through stock ownership. So I was hoping this use of the phrase would convey that.

Why is this important? As an example of “separated” thinking, there are directors who sit on boards who will say we don’t care about govenance — we are here to create value for the shareholder. Their statements are presupposing that the ideas of governance and shareholder value are separate and distinct.  I believe that is because the separate naming of the thing “governance” or “shareholder value”, along with the narrow way these things are described in common parlance, create an illusion of “otherness” — as if the concepts are not related. The separateness of the language contributes to a “separate camp” mentality i.e. “We are in the shareholder value camp, not the governance camp”. To my mind, in the long run, this “separate camp” thought process only produces lack of understanding not more.

So the usage of “invisible features” was there to try to bridge the chasm. We can all relate to these ideas from that standpoint I think — a feature creates a reaction in the mind of the customer. Nothing very controversial about that.

This edition of the digest was also seeking to present the conundrum of the choices we collectively make toward stability and instability — and how these are not either/or decisions. Humans exist with a need for both — and there are long term consequences that occur related to our choices. In the short run transfering risk to others could seem good in a very narrow sense, for example, but it has boomerang effects to those that transfer risks elsewhere that often are overlooked.

The digest also hoped to portray (without using the words) the concept of the butterfly effect, the sense that small motions like the flapping of a butterfly’s wings can set in motion impacts that are large — and unimaginable. For example, the digest explores the idea of the impacts of the movement over the last 30 years toward defined contribution plans. The digest also explores the idea of the impacts of the commonplace use of layoffs. Both were adopted as mechanisms to promote corporate flexibility. Both transfer risk from the corporation to the individual. But have they produced the intended consequences? (This is a question the digest explores.)

The idea of layoffs has not always been commonplace but has been adopted in a somewhat “me too” fashion over the years similar to the idea of “offshoring”.

With respect to layoffs I was witness to a dramatic event in the life of corporations which occurred when I was attending a disaster recovery seminar in New York City. I don’t recall the exact date though a New York Times article seems to indicate it was February 16, 1993. That’s the day “I.B.M. ended its no-layoff policy” according to the article. I remember that day because as you can imagine there were a lot of IBM’ers at this seminar, given the subject matter. They were in shock. This was a reversal of the tradition of a 100 year old company.There was a sense of betrayal that day that IBM’ers felt that was palpable even if they were not the ones impacted. It represented a change in a social contract not required or instituted by government but a social contract honored by a highly regarded corporation, one that had been in place for many, many years.

When we think about the causes for any event, we often think of the immediate causes. It’s human nature — but we think less often about other causes and conditions that created consequences but are not immediately near to what we are exploring.

Take, for example, the financial crisis. All the reasons given for the crisis are part of the equation and I’ve written about them and discussed them elsewhere.

But all our dialogue hasn’t really addressed the intentions which we must address. There has been talk of greed, of course, but this has been in a narrow context.

Our dialogue hasn’t yet sufficiently addressed some root issues and our intentions with respect to them which we must address if we are to move forward in a non-knee-jerk way. 

What I haven’t seen discussed is the series of choices we have made collectively, over the last decades, related to risk and instability which influenced the crisis we have faced. Of risk transfers which exacerbated the financial follies.

Coming out of the great depression, a decision was made that stability in employment was a worthwhile social goal as was retirement security. Since then, that resolve has been forgotten in corporate life.

That choice has consequences to financial markets and political systems. Obviously there are elements of society that can make money because of risk and instability — they can turn it to their advantage. What is more difficult, however, is for us all to not suffer the consequences of that short term choice.

The digest ends on a note of hope — that we can take stock and make other choices, recognizing that what we thought might generate flexibility actually may stand in its way –  something to consider as we make our way through the new complexities we have created in a world of butterfly wings and interdependency.

The Value Alliance and Corporate Governance Alliance www.thevaluealliance.com

Eleanor Bloxham www.eleanorbloxham.com

Copyright 2010 The Value Alliance Company. All rights reserved.

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Early in my career I ran a strategy and financial planning area — and designed and coordinated the budget process for thousands of employees. I gave up at least a couple of summers to this work which at that time was all consuming.

First hand I had the oppportunity to reflect on the downsides (that went beyond the long hours I put in) of traditional approaches to corporate financial planning, of budgeting processes, and tying bonuses to meeting or exceeding financial plans.

I’ve spoken about these downsides at conferences and written about them in my book Economic Value Management: Applications and Techniques http://www.thevaluealliance.com/economic_value_management.htm and in published articles. 

Now those downsides have been writ large in the story that is emerging about BP.

Yesterday, the House Energy and Commerce Committee released a letter to Tony Hayward explaining five instances in which BP’s employees had chosen to take cost saving rather than safety enhancing measures in the construction of the well.

References in the emails released by the Committee suggest that individuals at BP were highly cognizant of cost over-runs — and justification to “a plan” not necessarily explicitly discussed in-depth but ever “present in the room”.

In my book, I discuss some of the reasons traditional planning processes have become so popular. And despite that, what a small role (compared to the one they do play) they should play in corporate management. If nothing else, BP serves as an example of the harm they can do and the havoc they can wreck writ large across the Gulf of Mexico.

If we are to take heart that there is a lesson, beyond the event itself, one can be found in this. As a director, consider carefully the regularity with which plans are faulty and evaluate how good any company really is at planning (did your company forsee the breadth and depth of the financial crisis?). Consider this carefully before you consider tying peoples’ performance, reputation, promotion and pay to “plans”.

Consider carefully also the harm, as BP has shown, of doing so.

The Value Alliance and Corporate Governance Alliance www.thevaluealliance.com

Eleanor Bloxham www.eleanorbloxham.com

Copyright 2010 The Value Alliance Company. All rights reserved.

(We now have a mechanism to provide you with email alerts of posts. To receive email notifications of posts, simply click here. http://www.thevaluealliance.com/bloxham_voice_email_alerts.htm) 

As I was perusing the Financial Crisis Inquiry Commission website, I ran across an exhibit  “Moody’s Correlated Binomial Default Distribution”.

It made me think about a conversation I had with someone at Moody’s about issues in capital attribution models using the binomial, in which I pointed out that the binomial modleling wasn’t an accurate way to model capital requirements.  

The math was easier to do using the binomial, I was told. (And everyone agreed that it was and did it that way.)

I talk about the fix to using the binomial for risk capital calculations and why it is important, in my book, Economic Value Managment: Applications and Techniques  http://www.amazon.com/exec/obidos/ASIN/0471354260/thevalueallia-20. The book shows an example of how the binomial consistently understates the risk/the amounts of capital required.

It also reminded me of a conversation I had yesterday with a group of directors in which I was discussing the importance of considering risk costs when making decisions.

One of the directors present asked me to relate an example where I’d used this so I picked one which impacted the financial crisis.

I told them about the securitization analyses I’d been involved with related to the risk of securitizing sub-prime and credit card portfolios.

If one ignored risk costs, securitizing these assets might make sense. Securitization provided a pop to earnings, which  managers liked. It had a downside though that has been likened to cocaine — a merry go round once started it is difficult to get off – once you had that pop to earnings it was difficult to resist replenishing it.

In contrast, I explained that if you included the risk costs of securization in the decision making model, securitzing these portfolios was “non-economic” i.e. non-value creating for the bank originators — all the advantage went to the investment banks who earned fees for putting them together.

The point of my story was that including risk costs in decisions can make a big difference and should be a regular part of financial and strategic decision-making — but it’s not often done. (I talk about this too in my book – i.e. how to include risk cost in decision making — and I outline the securitization example/analysis.)

Maybe of interest, I also told them this personal story related to the selling of securitizations by investment banks early in the life of my firm, which I founded in 1999.

I was approached by a person from an investment bank and another from a credit rating agency because they wanted to work together to sell securitizations and they wanted my assistance, to bring my “value cache’” as a sort of imprimateur in recommending securitizations to the banks.

I remember saying to them that every analysis I’d seen showed it was not in the best interests of the originating banks — it was non-economic for them –    Did they still want me to do it?

And the answer I received was yes.

I didn’t, of course.

For me, this is an example not just of risk modeling and making of strategic decisions but also how ethics and competency can get all muddled up.

Ethics and competence in a situation — Which is the chicken and which is the egg?

Guessing you have stories you have lived like this too where ethics and competence seem to intersect and become tangled.

The Value Alliance and Corporate Governance Alliance www.thevaluealliance.com

Eleanor Bloxham www.eleanorbloxham.com

Copyright 2010 The Value Alliance Company. All rights reserved.